Analysis

Don’t trust the recovery

October is traditionally a volatile month in the financial markets and we got a taste of those big swings today with risk appetite reversing suddenly. When U.S. traders arrived their desks, they found Dow futures down more than -300 points and currencies logging in steep declines during the European session.  After opening sharply lower and extending their slide in the first hour of NY trade, currencies and equities stabilized. Then shortly after the London close, there were reports that Senate Minority Leader Mitch McConnell offered a Democrats a short-term suspension of the U.S. debt ceiling that would keep the government funded into December. 
 
This is good news for the financial markets regardless of whether you see it as an olive branch or an attempt to diffuse criticism. Unfortunately, we don’t trust the rally because McConnell’s offer is only a short term solution. Republicans refuse to consider a long term increase to the debt limit and continue to push back hard on more spending vis a vis the infrastructure bill. We’ll be having this same conversation in late November / early December. 
 
Also, by eliminating immediate default risk, politicians have strengthened the case for tapering by the Federal Reserve next month. Investors took profits in stocks at the start of the week because of concerns about inflation and higher yields – it won’t be long before these worries return. There could be some relief in prices if the U.S. releases emergency oil reserves but this option is only a “tool that’s under consideration” according to Energy Secretary Jennifer Granholm. 
 
In the meantime, the U.S. dollar could resume its rise ahead of Friday’s jobs report. According to ADP, jobs rebounded more than expected in the month of September. Economists are looking for stronger non-farm payrolls and a lower jobless rate this week. Although the employment component of service sector ISM eased slightly, service sector activity as a whole expanded at a faster pace in September. 
 
Counterintuitively, the New Zealand dollar was the day’s worst performer. The Reserve Bank of New Zealand became one of the first major central banks to raise interest rates but their 25bp hike was smaller than the market hoped for. The New Zealand dollar sold off across the board, losing more than a percent of its value versus the greenback. It did not matter that they tightened for the first time in 7 years or that they said further removal of monetary policy stimulus is expected. Traders focused on the smaller move and rise in local coronavirus cases.

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